Article

Factual Summary: A commercial LC was issued to pay at sight for the sale of 26,000 tonnes of Extra Hard Pitch (Reprocessing Grade) for EUR 2,348,915.00. On presentation by Seller/Beneficiary, Issuer refused to honor, claiming that the goods description was discrepant. Buyer/Applicant agreed to waive the description in the following manner: "With reference to the above and further to your swift message dated 3/10/2006, We are accepting the documents with discrepancy and the payment will be made after 180 days from today. We accept to make the following payments". Seller/Beneficiary agreed and the LC was amended, changing it from payable "at sight" to payable against bills of exchange "230 days from shipment date".

Subsequently, a dispute arose regarding the quality of the goods, notwithstanding an inspection report by an inspection agency. With the maturity of the obligation pending, Buyer/Applicant moved for injunctive relief under the Arbitration and Conciliation Act of 1996 Section 9. After initially granting an interim injunction, the Single Judge vacated the order. This decision was affirmed by the intermediate appellate court. On appeal, the appellate decision was affirmed and the petition dismissed.

Legal Analysis:

1. LC Fraud; Injunction

Buyer/Applicant alleged that the failure of Seller/Beneficiary to resolve the quality dispute regarding the goods during the period when the accepted bills of exchange were pending constituted LC Fraud since Seller/Beneficiary "had dishonestly and with ulterior motive not resolved the dispute as raised by the [Buyer/Applicant] and in any event, an order of injunction should be granted, otherwise, it would not be possible for the [Buyer/Applicant] to recover the money released under the Letter of Credit as the Seller/Beneficiary is a foreign company from Iran and has no assets in India,"Seller/Beneficiary argued that there was no dispute as to the quality of the first shipment of goods, and then, as to only part of the second shipment, that the dispute regarding quality was currently being arbitrated, and that what was alleged was not fraud.

Citing U.P. State Sugar Corporation vs. Sumac International Ltd. [(1997) 1 SCC 568], the Indian Supreme Court noted that Indian law regarding injunctions against payment ("encashment") of bank guarantees or letters of credit is "well settled". The Court observed that "courts should be slow in granting an order of injunction" and that a bank must honor its obligation without regard to disputes by the parties to the underlying contract. The Court noted two exceptions to the independence principle in U.P. State Sugar, namely "(i) Fraud committed in the notice of the bank which would vitiate the very foundation of guarantee; (ii) injustice of the kind which would make it impossible for the guarantor to reimburse himself."

The Court explained that an injunction was justified when "it is proved that the bank knows that any demand for payment already made or which may thereafter be made will clearly be fraudulent. But the evidence must be clear both as to the fact of fraud and as to the bank's knowledge," quoting Itek Corpn. Case (566 Fed Supp 1210).

As to the exception based on injustice, the Supreme Court referred to Itek Corp. v. First National Bank, 566 F.Supp. 1210 (D.Mass 1983), aff'd, 730 F.2d 19 (1st Cir.1984), where an injunction was granted due to the inability of the Iranian hostage crisis. The Court stated that "exceptional circumstances which make it impossible for the guarantor to reimburse himself if he ultimately succeeds, will have to be decisively established" and that a court must be satisfied that the applicant had good reason for recovery against the beneficiary.

The Supreme Court stated the following principles:

"(i) While dealing with an application for injunction in the course of commercial dealings, and when an unconditional Bank Guarantee or Letter of Credit is given or accepted, the Beneficiary is entitled to realize such a Bank Guarantee or a Letter of Credit in terms there of irrespective of any pending disputes relating to the terms of the contract.

(ii) The Bank giving such guarantee is bound to honour it as per its terms irrespective of any dispute raised by its customer.

(iii) The Courts should be slow in granting an order of injunction to restrain the realization of a Bank Guarantee or a Letter of Credit.

(iv) Since a Bank Guarantee or a Letter of Credit is an independent and separate contract and is absolute in nature, the existence of any dispute between the parties to the contract is not a ground for issuing an order of injunction to restrain enforcement of Bank Guarantees or Letters of Credit.

(v) Fraud of an egregious nature which would vitiate the very foundation of such a Bank Guarantee or Letter of Credit and the beneficiary seeks to take advantage of the situation.

(vi) Allowing encashment of an unconditional Bank Guarantee or a Letter of Credit would result in irretrievable harm or injustice to one of the parties concerned."

In considering the facts of the instant case, the Supreme Court agreed with the trial and intermediate appellate court that there was no fraud because the dispute regarding the pitch content related only to 10,000 metric tonnes out of 12,503 metric tonnes. The Court concluded that "fraud must be in respect of the whole consignment and not in respect of a part of the same."

The Supreme Court also concluded that there was no irretrievable harm or injustice since Buyer/Applicant only proved apprehension. The Court also noted that Seller/Beneficiary's lack of assets in India was not determinative of this issue.

Comments:

This decision is significant as a systematic statement of Indian law regarding exceptions to the independence principle. The formula is traditional with respect to egregious fraud, echoing the lrading case, New York's Sztejn decision and in laying the burden on the person seeking the relief.

One of the requirements raises questions, namely that permitting a drawing "would result in irretrievable harm or injustice to one of the parties concerned." If this formula is in addition to the requirement of letter of credit fraud, then it is consistent with the approach of other countries which also require other factors in addition to letter of credit fraud (or which lessen the extent to which the LC fraud must be egregious where these other equitable factors are extreme).

If it states an alternative basis for relief, it does depart from the traditional formula. As the formula was been stated in the quotation from the UP State Sugar decision (noted in the 2012 Annual Review at page 528) however, injustice appears to be an independent ground.

If "fraud" means Common Law fraud, then some flexibility with respect to the grounds for relief is understandable. If it does not, then the factors that would constitute injustice probably would be subsumed into what is deemed to constitute LC Fraud or Abuse.

[JEB/enp

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